The Last Time We Had A Week Like This, US Government Borrowing Costs Surged

A rare occurrence in the U.S. government bond market last week
could be signaling a big upward move in yields is on the way.

Last week, three consecutive Treasury auctions, involving 3-year,
10-year, and 30-year bonds, "tailed"–in other words, the bonds
all ended up trading at higher yields than markets were pricing
before the auction–indicating weakening investor demand for
Treasury bonds after a big rally over the past few months.

Morgan Stanley head of U.S. interest rate
strategy Matthew Hornbach wrote in a note to
clients that "a week to remember is in the history
books," given that three Treasury auctions tailing in a row like
they did last week–which Hornbach calls a "hat trick
tail"–doesn't happen very often.

When the hat trick tail does happen, however, it can be a
precursor to a significant correction in the bond market. Here is
a table of what happened to Treasury yields after the last couple
of "hat trick tail" occurrences:

Morgan Stanley

The biggest correction in Treasuries that sent yields highest was
the last hat trick tail, which happened in October of 2010.
Hornbach writes that this time, we could see similar results:

From a timing perspective, the hat trick that occurred this
week most closely resembles the hat trick that occurred in
October 2010. Not only did they both occur in the second half of
the year (but well before year-end), they also occurred after a
significant bond market rally. Event-driven analysis should
consider such an occurrence noteworthy, and given the current
levels of yields, it might make sense to hedge exposure to higher
yields over the next month.

Here is a chart illustrating the massive spike in yields
after the most recent hat trick tail occurred in October
2010:

Morgan Stanley

Hornbach also noted that August tends to be a good month
for Treasuries, so if anything, the two opposing forces are
"likely to keep actual volatility higher than what we
witnessed over the past several months."